On Banks' Windfall Profits Driven by Tax Breaks and Regulation
Translated from Russian with the help of AI. Original: Russian version
Banks' windfall profits stem from tax breaks and regulatory conditions rather than the CIT rate, so raising CIT will not fix these imbalances. The author argues that removing the breaks, strengthening creditors' rights and encouraging corporate governance would do more.
Reading the proposals for the new Tax Code, I see that we try to solve every problem in a complicated and reactive way, without analysis or a view to the future. Over the past two years, banks have earned colossal profits while paying CIT at an effective rate of, let's say, less than 20%. There are objective reasons for this, and simply raising the rate for banks will not resolve them. The bulk of banks' excess income has nothing to do with the rate. It comes from tax breaks and from conditions that regulators have created for banks in the country, which allow them to earn very large sums. I have written about these many times, and I will briefly set them out once more:
A cap on interest accrual on current accounts, combined with a high base rate, allows banks to earn enormous sums (in my earlier publications I did the calculation; you can look it up).
Restrictions on foreign currency deposits, combined with high rates on international markets, allow banks to earn enormous sums.
CIT exemptions on income from bonds issued on the organized securities market, which covers all government securities and corporate bonds. Since banks keep most of their liquidity in government securities, they receive huge income without having to pay CIT.
High barriers to entry for other players in the second-tier banking market, which stifle competition and allow banks to hold dominant positions in certain niches.
Raising the rate for the banking sector does not at all mean that banks will pay higher taxes. The conditions being created will encourage banking holdings to shift profit to subsidiaries, affiliates and controlled entities. Large banks have shareholders who are major businessmen with interests well beyond banking, and they will be motivated to build superstructures to accumulate profit. One example is bond issues at elevated rates that the shareholders themselves would buy. Another is marketplaces set up separately that would take all the commission income. A third is insurance premiums paid out to insurance companies, and so on. In short, creating arbitrage between sectors will not fully stimulate the development of any one sector. It will instead encourage people to exploit that arbitrage and optimize their taxes.
We must also understand that banking is a highly cyclical industry. As the base rate falls, banks' incomes will fall with it. Excessive activity in consumer lending will likewise lead to higher NPLs in the future, which will reduce profits. Then we will cut the rate again, because bank capitalization will need support.
If we want banks to pay more tax, we need to remove the breaks for the banking sector. If we want to encourage lending to the real sector, we need to expand creditors' rights, remove barriers to recovering problem debt, provide more information for assessing companies' creditworthiness, discourage business fragmentation, and promote the institutionalization of companies through the introduction of corporate governance.
As for the reduced CIT rate for the manufacturing sector, it will also encourage companies to shift all their profit into production units, which will lead to an overall decline in the country's tax base. In my view, given that the top priority is to increase budget revenues, such initiatives will have the opposite effect, and in a couple of years we will urgently have to amend the Code again.